On January 15, 2015,
early in the morning, a flash from The Economics Times showed Rupee opened
higher by 46 paise against the dollar at 61.72[1].
Fluctuations in the value of rupee is a daily occurrence, but the jump of 46
paise in the value of rupee on January 15 was not consistent with the economics’
principles. In principles of economics, cost of money is represented by the
prevailing interest rates in the economy. With reduction in interest rates, the
cost of money goes down which leads to increase in supply of money into the
country’s financial system. This increase in supply of money in turns results
in weakening of the value of the currency because of demand-supply principle.
Recently, Russia to defend Ruble from weakening raised its interest rates very
steeply from 10.5% to 17%[2]. On January 15, RBI, in a surprise
move, cut the repo rate by 25 basis point to 7.75%. Ideally, this should have
resulted in decrease in the value of rupee, but it steered to 46 paise jump in the value of rupee[3].
This is not the only
shiny story about Indian rupee. With the impending roll back of Quantitative
Easing[4] by US Federal Reserve, many
currencies have depreciated by 10 to 12% against the dollar with Indian rupee
being the only exception which is at the same level in comparison to last year.
Indian rupee is expected to outperform
its Asian peers in 2015 as well[5].
Much credit of these
stories goes to Mr. Raghuram Rajan, governor of RBI. But, what are the reasons
behind such performance of rupee? The immediate reason of such performance is
strong inflow of foreign exchange into India. In year 2014, portfolio investors
invested almost $ 40 billion into Indian securities[6]. On January 15, Sensex and
Nifty jumped by 2.19% and 2.12% respectively on strong buying from foreign
investors. The performance of rupee is directly related to the movement of
foreign exchange into the country. Strong inflow of foreign exchange in India which results in higher demand of rupee is the reason of such performance of rupee.
Value of rupee should be
at optimum level so that country’s export and import, both can be benefited.
Rather strong rupee may hurt country’s export by making country’s good/services
less competitive in comparison to goods/services of another country. Due to
strong rupee, exporters get less rupee on the conversion of foreign money than
they would get at a weaker rupee, this reduces the ability of exporters to offer
their goods/services at cheaper price. The opposite corollary is true for
country’s import. RBI, sometime to defend rupee from depreciating , sells dollars in the market to
increase the supply of the dollars. Weaker rupee makes import costlier and thus
raises the inflation level in the country. So RBI tries to maintain rupee
stable through rare but timely interventions into the market. Value of rupee is
determined on the floating exchange rate basis i.e. on the basis of demand and
supply of rupees against foreign currencies. Therefore RBI intervenes only when
there is unreasonable fluctuations in the value of rupee.
On February 6, 2015,
India’s forex reserve reached all time high at $ 327 billion[7]. India has ninth largest
forex reserve in the world with China at the top of the list with over $ 3
trillion. India’s forex reserve may look insignificant before forex reserve of
China, but India has come a long way since 1991. In 1991, India had only so
much forex reserve which could cover only three weeks’ worth of import. Now,
India can cover imports of more than eight months with current level of forex
reserve[8].
The ability of any country
to attract foreign exchange depends upon the performance of its economy. After
short spell of recession in Indian economy, the recovery is being felt across
all the sectors. In the midst of changed political landscape, India offers the
best opportunities of growth in the world. If the current government has its
way, India can achieve almost 9% growth in next couple of years. Make in India
initiative of govt. of India has the potential to attract huge Foreign Direct
Investment into the country. Given the current sense about the India’s economy
around the world, India will continue to attract foreign exchange in large sum.
There are real possibilities of starting ‘Acche
Din’ soon for Indian economy.
This part was aimed at
giving readers a sense of impact of foreign exchange on country’s financial
system. Next part will be focused on current and capital account transactions
and the rules of convertibility of these accounts. FEMA is premised upon the
basic classification of foreign exchange transaction into these the two
different accounts.
[1] Rupee
Soars, Sensex, Nifty Vault < http://www.businessworld.in/news/finance/markets/rupee-soars-sensex-nifty-vault/1700029/page-1.html
Last Accessed at February 4th, 2015>
[2] Russia
Raises Interest Rates To 17% To Defend Ruble; Might Work, Might Not <http://www.forbes.com/sites/timworstall/2014/12/16/russia-raises-interest-rates-to-17-to-defend-ruble-might-work-might-not/,
Last Accessed at February 4th, 2015>
[3] Rupee
Surges to Two-Month High <
http://www.nasdaq.com/article/rupee-surges-to-twomonth-high-20150115-00089 Last
Accessed at February 4th, 2015>
[4]
Quantitative Easing is a tool of monetary policy under which US Federal Reserve
(“Fed”) buys financial securities from market every month that result in fresh
money being infused into the system. This increased supply together with
historical low interest rates results in weakening of US dollar.
[5] Indian
rupee to outperform Asian peers in 2015: HSBC
< http://www.moneycontrol.com/news/rupee/indian-rupee-to-outperform-asian-peers2015-hsbc-_1248457.html?utm_source=ref_article Last Accessed at February 4th, 2015
>
[6]
Net FII inflows in India set to touch $40 billion <http://www.livemint.com/Money/pD2vVeZE9e3ah0odim8qOL/Net-FII-inflows-set-to-touch-40-billion.html?utm_source=copy
Last Accessed at February 4th, 2015 >
[7] Forex
reserves touch all-time high of $ 327.88 billion <
http://articles.economictimes.indiatimes.com/2015-02-06/news/58878901_1_reserve-position-non-us-currencies-overall-reserves
Last Accessed at February 4th, 2015 >
[8] Forex
reserves swell to over $300 billion, enough to cover imports of 8 months <
http://articles.economictimes.indiatimes.com/2014-07-28/news/52139176_1_import-cover-foreign-exchange-reserves-external-debt,
Last Accessed at February 4th, 2015 >
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